In January of 2014, The Nelson A. Rockefeller Institute of Government issued a report titled “Strengthening the Security of Public Sector Defined Benefit Plans”.[1]

The report makes a compelling argument that the proper rate for valuing pension liabilities on financial statements is separate from the question of what pension funds assume they will earn on their investments.

A More Accurate Estimate of Ultimate Cost

Rather than valuing future liabilities based on the “assumed rate of return” declared by the pension system, the report says a fairer picture of the true cost of the plan for all stakeholders would be a discount rate tied to some instrument like high quality municipal bond rates.

It is important to emphasize that this study, and others like it, aren’t opposed to retirement systems setting target or “assumed” rates of future return for investment purposes. The important distinction is that, for financial statements, it would be far more reasonable to use a discount rate from actual market instruments, instead of some “assumed” long term rate in the future.

Nothing to be Afraid of

Unfortunately, many public retirement systems have taken a negative view of this proposal. The fear seems to be that taxpayers and other stakeholders will be shocked by what they see as the potential long -term cost of the plan, when measured more conservatively. In that regard, the study does not argue for valuing such plans on a “risk free” rate of return, as have some other similar studies. Instead, it advocates for the use of a discount rate on high quality municipal bonds, or something similar.

Administrators of public retirement systems should not fear using such a measurement. In actuality, it would help the longer- term health of these plans if there was a more frank and realistic discussion of what the costs of these plans could be, particularly if they are not managed prudently. It would also make politicians less likely to skip or reduce required pension payments since it would highlight the impacts of under-funding more significantly.

Stakeholders deserve a more honest assessment of what these plans will likely cost. Shareholders in a corporation may vote with their feet by selling shares in a company that is not properly managing its pension liabilities. Taxpayers, on the other hand, can’t opt to do the same thing unless they pick up and move to another locality, which can be a costly and impractical proposition.

Being Well Informed is Better Than Ignorance

Since as much as 70% of the benefits from a retirement system can be derived from investment returns, it is of course important to maximize earnings as prudently as possible. However, it is equally important to minimize risk, and to evaluate those risks in the most realistic fashion. Keeping stakeholders in the dark about the true ultimate costs of these plans will only increase the negative feelings and apprehension that has been building against public sector defined benefit plans for the past decade. A more honest and forthright estimate of potential costs will serve to benefit public employees in a number of ways, including making required funding payments and avoiding political tampering with benefits and cost estimates. In the long run, that will not only bolster the financial security of these plans, but also make them more respected for being prudently managed.

I encourage you to read the full report at www.rockinst.org.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

[1] The Nelson A. Rockefeller Institute of Government is the public policy research arm of the State University of New York. The full report may be accessed at www.rockinst.org

Recent competitive bids to ensure that they are offering the best services at the lowest cost in the market, for both recordkeeping, and investment services.

A variety of corporate plans are showcased, each one with an impressive track record for effective plan governance that puts the interests of employees above all else. That is, of course, until you scroll over to see the article on the Public DC award.

Public Employees Come Last

The public DC plan to receive the award has three different record keepers, 83 investment options, dismal usage of default investments, and a somewhat average participation rate. The investment offerings are, for the most part, mediocre and quite expensive for a plan with over $200 million in assets. With 83 investment options, the City has severely diluted its ability to negotiate lower fees from investment providers. There is rampant duplication of fund asset classes, and no clear way for participants to discern what are the least costly and better performing options among the 83 fund array. There is a proliferation of proprietary-investment funds that would never survive an independent competitive fund review in an open and independent public bid process. The investment providers, sales brokers and unions appear to be running the show, all to the detriment of the plan participants.

An Award for Perseverance Against Adversity Rather Than “Best Practice”

Ironically, the article on the Public DC Plan is really a feature about the efforts of a dedicated employee in the Human Resources (HR) department to “fix” the Plan, over the objections of the DC Board that (apparently) runs the Plan. Instead of a “best practice” example (which is the theme for the corporate plans recognized) the article champions the efforts of a HR employee to remake the Plan into something far better for the employees. In that regard, the article is very kind given the history this Plan has for lack of transparency and self-dealing.

To their credit, the City did undertake a public bid process a couple of years ago. Sadly, the public bid was never concluded in a meaningful way for Plan Participants:

At least one union objected to any independent review of the Plan, in particular the option endorsed by them (for which they are receiving a fee from that particular provider).

Another vendor undertook a nasty campaign to toss out the entire public bid process. At one point in their letter this vendor says their current contract is “open-ended and the City is not obligated to issue a RFP (Request for Proposal)”. Really? So it is a never-ending contract that should never be reviewed by anyone?

Sadly, the City caved to pressure from investment companies and unions and made no real significant changes. Investment options were cut back from over 100 to 83, but little else (for participants) changed. The real losers were the Plan Participants who, for a City of this size, have a confusing and very expensive program.

Transparency Issues Ignored

There was no attempt to fix the transparency issues for this Plan, during or after the failed bid process. For example, there is no up-front disclosure that two of the three providers pay fees to third party unions or associations in return for an endorsement. There’s nothing inherently wrong with endorsement fees provided the fees are disclosed to Plan Participants (which they are not, at least not easy to find) and that the endorsing entities perform some regular due diligence on why they endorse that particular company. In both instances here there is no documentation that a public bid or independent evaluation has ever taken place to award the endorsement to either vendor. Perhaps there has been, but it is not disclosed to Plan Participants. The City could have easily fixed this by demanding full disclosure from all three vendors. They obviously chose not to.

Public Employees Finish Last, Again

So the bottom line is that the PLANSPONSOR® awards for corporate plans recognize “best practice” fiduciary responsibility where governing boards and committees take action based on the “best interests of plan participants and their beneficiaries”[1]. Sadly, the award for the public sector DC plan focuses on actions by a single employee to (try) to overcome inaction by a governing board that obviously views its constituents as the Plan vendors and unions instead of their employees.

This is not the only City in America to undermine the interests of Plan Participants by failing to successfully conduct regular, independent reviews of all aspects of their program. Fortunately, most other large cities take their responsibility seriously and conduct frequent, independent bids to ensure that all aspects of their program are competitive, contemporary and in the “best interests of plan participants and their beneficiaries”[2].

Maybe next year the Public DC award will be given to this particular City for actually fixing their program. Or, if history repeats itself, the heading of the award for this City might as well be titled “Don’t Let This Happen to You!”

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

More and more plan sponsors have moved to create Custom Stable Value Funds for their plans over the past decade, and this has been a tremendous benefit for plan participants. Custom Stable Value Funds offer greater fee transparency, lower fees (in most cases) and avoid the risks inherent in “pooled” arrangements with other plan sponsors over whom you have no control. They also permit the plan sponsor to exercise more control over investment policy and portfolio quality.

Evolution of “Multi-Manager/Multi-Wrap” Stable Value Funds

When most plan sponsors first created their Custom Stable Value Funds, they were usually composed of one investment manager and one “wrap” provider. The “wrap” provider (generally an insurance company) guarantees liquidity for book value benefit payments to plan participants. In some situations the investment manager was also the wrap provider and in other situations the wrap provider was different.

As the assets in Custom Stable Value Funds have grown, there has been a trend to move away from “single -manager/single- wrap provider” arrangements to “multi-manager/multi-wrap provider arrangements.” Some consultants recommend the “multi-manager/multi-wrap” design because they argue that diversification of managers and diversification of wrap providers is better than the “single –manager/single-wrap provider” design. However, a recent analysis of several large Governmental Custom Stable Value Funds calls into question whether the “multi” arrangements have any real benefits for plan participants. To the contrary, the analysis shows that most of these “multi” funds have significantly higher fees and lower yields than their “single” counterparts.

For our analysis, we examined publicly available information on over two dozen large State, County, and City defined contribution programs. While the sampling was random, it included a diverse number of plans with different vendors, managers, consultants and plan designs.

Without exception, every single “multi-manager/multi-wrap” Custom Stable Value Fund had higher overall fees, and lower overall yields than funds of similar size that used the “single-manager/single-wrap” design.[1]

In some situations the differences were startling:

Two adjoining states have Custom Stable Value Funds. For the one state (let’s call it State ‘A’), the assets in the Custom Stable Value Fund are about $2.0 Billion. For the other state (let’s call it State ‘B’) the assets in the Custom Stable Value Fund are just over $1 Billion, or about half of the asset size of State ‘A’.

A few years ago, at the recommendation of their consultant, State ‘A’ converted from a “single-manager/single-wrap” to a “multi-manager/multi-wrap” arrangement. When the conversion was made, the total fees for the Custom Stable Value Fund maintained by State ‘A’ increased nearly three-fold. According to the fund summary the total fees for investment management, fund oversight, and administrative fees are approximately .44%. Fees are paid to multiple managers, multiple wrap providers, and a separate entity that oversees the “cash buffer” of the fund. The average yield for last year appears to be about 1.80% according to the plan web site.

Conversely, State ‘B’, which has a Custom Stable Value Fund that is half the size of State ‘A’ has total fees (investment management, book value wrapper, and administrative fee) of approximately .20%. The average yield for last year appears to be about 2.60% according to the plan web site.

Investment policy and other primary features are similar, yet the fees for the “multi” arrangement appear to be three times the cost of the “single” arrangement when investment management fees are compared side-by-side with administrative fees removed. To add to the irony, the fund with the higher fees is twice the size of the other fund, which would generally not be the case.

The pattern outlined above was similar for all of the funds examined. A large City and a large County in California (with different vendors and consultants) both converted from “single” to “multi” fund structure for their Custom Stable Value Funds at about the same time. In both situations, overall fees increased two to three times over the prior arrangement, and the net yield to participants plummeted. Other variables such as credit quality and investment policy were similar.

We could not find a single example where a conversion from “single” to “multi” designs lowered fees or improved yields.

The “Diversification” Argument

Consultants who advocate “multi” arrangements cannot argue with the fact that these arrangements are almost always more expensive and incredibly more complex to manage. However, they argue that there are benefits to diversification. If so, then what exactly are those benefits? Where is the data that show some future “benefit” of higher fees and lower yields? Some advocates of “multi’ arrangements speculate about fund-meltdown scenarios in which a “multi” wrap fund may have greater protection, but there are no actual facts of such situations to justify the higher fees. If one of your wrap providers fails, it makes little difference whether you have one wrapper or many – the fact is you have to replace the wrap provider who no longer meets your credit quality guidelines.

“Top of Scale” Fees

One of the most basic flaws of “multi” arrangements is the fact that plan participants lose the advantage of downscaling fees that nearly all fund managers offer. The more money you place with them, the lower your fees. So, when you hire five managers in place of one, you are at the top of the fee scale for all of those managers. That is one reason for the large increase in management fees in “multi” arrangements, and it is a disadvantage that does not go away.

Other Common Myths of the “Multi” Custom Stable Value Fund Design

Manager “Style” Specialty

Managing bonds is not like managing stocks. Stocks are different, and different managers have different specialties. Bonds don’t have characteristics like stocks. Once you determine what percentage of your portfolio you want in AAA Corporates, or Government-backed securities, Treasuries, etc, nearly any large manager can go to the market and very efficiently purchase and manage your “basket” of bonds. Assuming your Investment Policy Statement for the Fund is clear, there’s not much room for “discretionary” choices like there are in stocks. The argument that a collection of bond managers can provide better selection and management than an overall manager is dubious when it comes to the size of the vast majority of Custom Stable Value funds. An exception would be in private placements, but this would not be a fund holding for the vast majority of Governmental defined contribution plans.

“Wrapper” Diversification

Whether you have ten wrap providers or one, the main issue is credit quality and the ability to guarantee book value benefits. It’s easier to monitor and oversee one wrap provider than a variety, many of whom are small and have lesser credit quality than the larger firms. In one recent large plan that was out to bid, one of their wrap providers had already fallen below the minimum credit quality standards and was technically ineligible to be a wrap provider. This fact was pointed out by a potential bidder. Neither the consultant or plan sponsor was aware of that fact. These “multi” arrangements have many moving parts and require a higher level of oversight.

A Bummer for Retirees

Retirees are still big users of Stable Value Funds. In once recent conversion from “single” to “multi” fund design, the fund yield dropped over .50% on the date of conversion due to higher fees investment management fees and a doubling of wrap fees. Retirees were understandably upset. When fixed yields are already at historic lows, a drop of .50% in yield can mean a big difference in draw-down income for retirees.

High Fees in a Low Interest Rate Environment

In a double-digit interest rate environment, a fee increase from .15% to .40% is not nearly as painful as the same increase in an interest rate environment where the gross yield is hovering around 2%-3%. In the current environment, every penny of fixed income yield makes a difference, so it is hard to justify the hefty fee increases in “multi” arrangements, regardless of the hypothetical arguments on diversification.

For huge Custom Stable Value Funds over $5 Billion, there are some scenarios where a dual or triple manager arrangement may make financial and investment sense. And, for some jumbo funds, one wrap provider may have a limit on the risk they will underwrite. But for the vast majority of Governmental Custom Stable Value Funds, the “multi” arrangements are just a bad deal for the participant, and a fee bonanza for the consultant.

Conflict of Interest Abounds

One of the more disturbing findings in our analysis is that in over half the situations examined, the consultant who recommended the “multi” design is also the manager of the new arrangement. A prudent plan sponsor should never permit that to happen. In a couple of situations, the consultant billings increased two fold after moving to a multi-manager/multi-wrap arrangement. In both situations, participants pay the consultant fees from fund revenue.

As we have discussed before, a plan sponsor should never permit a consultant to benefit from a recommendation he or she makes for a new product or service. To be certain your consultant is recommending a “multi” arrangement for the right reasons (if there really are any) be sure to tell them that they cannot be hired as a manager or provider for any services in any plan design or product structure they recommend.

For more information on this topic see the related article “Does Your Consultant Have a Conflict of Interest?”, February 5, 2014.

Not the Last Word…..

The debate on this issue will continue, of course. However, given the facts of high fees and falling yields in the market, “multi” arrangements will continue to be under pressure to justify this cumbersome and expensive fund design with no clear advantage for plan participants. If rates continue to fall, it is conceivable that in some of the worst of these arrangements, the fees will outstrip the income to the point where the net yields drop below 1.00%. The important question for the plan sponsor to ask is who really benefits from a conversion to a “multi-manager/multi-wrap” fund design, and who will suffer?

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal and investment advice on this issue.

[1] One exception being a Custom Stable Value Fund with over $10 billion in assets, for which a comparable fund was not examined.

Having just returned form the 2014 Annual Meeting of NAGDCA (National Association of Government Defined Contribution Administrators) in San Antonio, I am struck by how little has really changed in the government market in the past 35 years.

I have a soft spot in my heart for NAGDCA. I attended both of the original formation meetings in Chicago in 1980 and 1981, and attended the first Annual Meeting in Biloxi, Mississippi in 1982. I also helped create, and served on, the first Industry Board. I’ve attended all the Annual Meetings except two.

While not unique to NAGDCA, it seems that most pension conferences just keep having the same sessions on the “retirement crisis” in America; too many people saving too little. Every year, there’s another public figure, academic or media personality telling us how bad the crisis is. But we know all that. We’ve known that for over three decades.

What we need to focus on is what to do about it.

It’s time to stop diagnosing the problem and focus on the cure:

Automatic Enrollment and Automatic Escalation

Every government defined contribution plan in American should be compulsory when you are hired. Period.

Employees are free to opt-out, but we know that only a fraction will. Every plan sponsor should be actively implementing this. If your state has garnishment or other laws that prohibit automatic enrollment, you need to focus on changing the law. Go to your state capitol and explain the issue. Be sure your local city council or county commissioners pass a resolution endorsing a change in the law. Get legislative and vendor sponsors, and get your public employee unions on board.

In my nearly 40 years in the public sector pension market, I’ve seen providers and plan sponsors spend hundreds of millions of dollars over decades to improve enrollment. Advertising campaigns, videos, splashy brochures; yet we have barely moved the needle on “voluntary” enrollment. It’s time to stop wasting money on things that don’t work and focus on making automatic enrollment and automatic escalation our number one priority. Don’t take “no” for an answer. We all know that the inertia of automatic enrollment really works in the long run so let’s just get that done for every governmental defined contribution plan in America.

Scrap The Individual Fund Selection Process

If the “people aren’t saving enough” theme is the number one recurring topic at pension conferences, a close second is the “people are poor investors” sessions. Ok, we get it. So let’s do something about it.

Enroll everyone in managed accounts, target date funds, or risk-based asset allocation funds. Discourage participants from individual fund selection. Make them sign a form that they are a “knowledgeable investor” before they pick their own funds in an alternate core line up or brokerage account.

Most of the evidence points to managed accounts as the best way to structure a portfolio that takes into account your defined benefit plan, the pension plan of a participant’s spouse or partner, and other factors such as social security or personal savings. Target date funds can’t and don’t do that. While it is true that portfolios in managed account programs may be similar to those in target date programs, the big difference is that managed accounts put the participant into the fund that is right for them, based on their unique set of circumstances (of which age is only one of the factors). Target date funds can never measure up to that degree of customization. They just aren’t designed to operate that way.

However, if you can’t offer managed accounts for a reasonable fee, then opt for target date funds. They are far from perfect. The “off the shelf” target date funds are often tailored for the corporate 401(k) market, and many are loaded with proprietary funds of the investment manager. Custom target date funds are great for jumbo plans but they carry added fiduciary risk and are really only economically feasible for very large plans. Nonetheless, anything is better than asking your participants to pick from an investment menu of mutual funds. So if you don’t opt to put your participants in managed accounts, target date funds are a good second option.

Risk-based funds are also another option. Given the issues with target date funds (one size fits all for people in a certain age bracket) the risk-based alternative at least permits some degree of customization if the participant has other retirement plans and/or personal savings or a spouse/partner with another retirement plan. However, most participants will need help selecting a risk-based fund so if you can’t easily offer that, then stick with managed accounts or target date funds.

The important thing is to scrap individual fund selection. Only a small minority of participants really do it well, and most plan sponsors spend way too much money and time “monitoring, hiring and firing” specific fund managers for asset classes that most participants don’t understand or use wisely. For the very small percentage of people who are capable of constructing their own portfolio, let them do it in the brokerage account. There’s no need for the plan sponsor to “select or edit” core funds for knowledgeable investors, so just scrap individual funds. Think of the time and money you will save when you end this practice that is really of little long- term value to the bulk of your participants.

3. It’s Time to Reallocate Your Plan Governance Dollars

Once you have all of your employees in the plan, and safely tucked into a managed account, target date, or risk-based fund default option, it’s time to spend your consulting fees and investment advisory fees in a more creative manner.

Providing your plan participants with projected future income statements is a great starting place. Ideally, you should include all future sources of retirement income; your defined benefit pension plan, the defined contribution plan, personal savings, retirement income from a spouse/partner and even social security, if applicable. This tool would a far better way to spend plan-level funds instead of wasting money on individual fund selection and monitoring.

Once you no longer have to worry about enrolling participants and helping them select investment options, your plan vendor (record keeper) can devote resources to counseling sessions with participants and their spouse/partner to help them understand their retirement income projection statement. All of those boring and repetitive “enrollment meetings” would be replaced with personal counseling sessions (every two years, at least), where the focus would be on the projected retirement income statement, and not on plan investments or other topics that simply confuse the bulk of participants.

No One Ever Complained About Having Too Much Money in Retirement

It’s highly unlikely any participant is going to be angry at their employer for making them save too much money for retirement. It’s time we really focus on what actions we can take that truly help our employees. Unfortunately, it takes a bit of courage to step over a chasm of good intentions and make decisions that really have a profound and positive impact on the financial well being of employees. It is far easier to stick with the status quo, even if it isn’t working well.

The deck is stacked against this type of transformative change. The existing infrastructure of the government defined contribution plan market (and to a degree the DB market as well) is loaded in favor of the government and private entities that benefit from the existing and inefficient plan architecture. But this change will occur, because there are leaders in the market, both in the public and private sector who know these are the changes that need to be made. They are prepared to step over the chasm to make these important changes happen, and transformative change will ultimately occur. Your choice is to be a leader, or one of the followers.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice.

An article Gregg wrote on exemplary pension reform efforts at the City of Baltimore was published Friday, August 8, 2014 by Plan Sponsor. Standard & Poor’s recently upgraded City of Baltimore Bonds to AA, citing improved financial conditions for the City.

Plan sponsors who follow “best practice” guidelines conduct formal bids on a regular basis to ensure that their plan participants have the most attractive program available. A bid process is normally referred to as a Request for Proposals (RFP). A prudent plan sponsor will generally issue an RFP at least every five years. Some state or local ordinances may require formal bids on a more frequent basis.

One of the most common requests we receive is for some guidance on what should be in an RFP, and how to score the proposals you receive. One of the best ways to develop your own RFP and scoring methodology is to request samples from other public plan sponsors with plans of similar size and characteristics to yours. Or, if you hire a consultant to assist you with a public bid process, they will likely have a RFP and scoring format that they use. You should evaluate several RFP’s and scoring mechanisms before concluding upon which is best for you. It is generally advisable that your criteria and scoring be consistent for various bids, if possible. This makes it easier to score and evaluate proposals on a consistent and unbiased basis.

A sample Annotated RFP is available from our firm, which contains a listing of the most commonly asked questions in an RFP. There is also a sample scoring and evaluation criteria, with scoring ranges that are most commonly used by plan sponsors for public employee defined contribution plans. Both documents are available to you free of charge. Please simply send your mailing or email address to info@gregoryseller.com and we will be pleased to send you the documents in hard copy or electronic format.

The sample Annotated RFP and Scoring Suggestions are for information and educational purposes only, and are not legal or tax advice.

Employer funds a smaller DB benefit (i.e; 1% of pay times years of service)

Employee funds a DC account (5%-10% of payroll)

Cash Balance Plan

A DB Plan funded like a DC Plan

DC Only Plan

401(k) style plan like those used in private sector

Summary

”Pension Reform” of some type is affecting all cities

The Steps You Must Take Depends on a Variety of Factors:

Funding status of your plan

Affordability

Political climate back home

Stakeholders (employees, unions, taxpayers) interests

The Important Thing is to Take Action While You Have Many Options Available – Waiting Too Long Reduces Your Options

*Source: NASRA, April 2014

The above presentation is for information and education purposes only. It is not legal or investment advice. The presentation solely reflects the views of the presenter and not the United States Conference of Mayors or any of the co-presenters.

Some plan sponsors in the pubic sector have added vendors to their IRC Section 457 or other plans as a result of collective bargaining with one or more public employee unions. This can be a risky decision that is fraught with potential problems for both the employer and employees.

While at first this may seem an easy benefit to provide that is not costly to the public employer, it is a practice that may have financial consequences for the plan sponsor in the long run:

1. Fiduciary responsibility trumps collective bargaining

A number of rulings and lawsuits have made it clear that the plan sponsor must act “in the best interests of plan participants and beneficiaries.” Most recently, the 8th U.S. Circuit Court of Appeals affirmed the position of the Department of Labor that the plan sponsor must prudently monitor fees paid to plan providers. Failure to do so can result in financial liability for the employer.[1]

Adding another vendor simply because it was a condition of collective bargaining does not relieve the plan sponsor of its duties to monitor fees and other plan features in the best interests of plan participants. Many union-sponsored arrangements are “bundled” arrangements over which the plan sponsor has no control in the area of fees, investments or features. Yet, while the plan sponsor cannot control these elements, it remains the plan fiduciary. In other words, you have all the risk but someone else is making all the decisions.

2. Adding a program that failed an independent review

In many situations, another vendor was added as an available option even though that program failed to pass an independent public bid evaluation process. This not only applies to union-sponsored programs, but situations where a local broker or financial adviser proposed a program that failed to pass muster in a formal bid review process, yet was added later due to political or collective bargaining pressure. This is never an acceptable action for a prudent plan fiduciary.

3. Increased risk of liability for failure to disclose available options

How would you respond if this situation unfolded at your city, county or special district?

A plan sponsor selected a vendor for their plan following a competitive bidding process. A consultant was involved, along with a review committee. The result of the process was to select a vendor that ranked highest according to the criteria of the public bid. The plan sponsor entered into a contract with that vendor.

Shortly after the bid process, a union bargained for their endorsed program to be added as a secondary option for employees. The employer, in a collective bargaining process agreed. The union program had been submitted for consideration in the original process to select a single vendor, but it scored poorly compared to other bidders and was not selected for general employees.

Nonetheless, the plan sponsor added the second vendor as a result of negotiations with one of the unions. The union routinely signed up new union employees in its endorsed program. About a year later, a union employee who automatically joined the union endorsed program discovered that another program was also available, when his spouse took a job with the same employer. As a general employee, she was enrolled in the program that was created as a result of the public bid process. Both employees were confused as to why they were enrolled in separate programs. The general employee spouse worked in finance, so she prepared a comparison of her program and the program her husband was enrolled in. Both spouses were surprised at the high fees and poorer performing investment options in the union sponsored program. They were also surprised to learn that the union was receiving a share of the fee revenue from the endorsed program. That fact was not disclosed to participants at enrollment.

The union employee then claimed that he was never made aware of the alternative plan when he joined the public entity. He alleges that the employer was negligent in failing to inform him that he was eligible for another less expensive plan. He also alleges that the employer failed to inform him that the endorsed plan had been independently reviewed, but did not score well and was therefore excluded from consideration for general employees.

This is a nightmare situation for any public plan sponsor. In this instance, the plan sponsor exercised due diligence in selecting one vendor for all employees, but did not do so in signing a contract for another segment of employees. Furthermore, the employee automatically enrolled in the union plan allegedly had no knowledge that he could have joined the other plan.

So, the question is:

Is this simply a disclosure issue for the plan sponsor, or;

Would this be viewed as the plan sponsor turning their back on their obligation to be certain that all of their offerings were “in the best interests of plan participants and their beneficiaries?”

If the plan sponsor could be held liable for their decision (as indicated in Tussey v. ABB) then the financial ramifications of this situation could be severe.

4. The role of a third party sponsor

Public employee unions play an important role for their members and constituents, so the issues raised in this article are not negative towards unions or other third party sponsors of programs. To the contrary, third party oversight can be helpful, particularly for smaller public employers who cannot afford an independent consultant and/or who don’t have the expertise to conduct a full market review or public bid.

One major area of concern on third party sponsored programs is how independent the sponsor is from the vendor they have selected. I took a look at the four largest union and third party affinity sponsored programs used in the public sector. Of the four, one had conducted a public review with an independent consultant in the past five years, and openly discussed the findings of that review with participating entities. It was not clear from publicly available information what public reviews or bids were undertaken recently by the other three sponsoring organizations. Only one of the four had information about a public market review on their web site. There was no mention of independent reviews on the other sites. Interestingly, only one of the four had actually changed vendors in the past several years. One appears to have had the same vendor for over 30 years.

These findings don’t imply anything bad or improper with endorsed programs. However, any prudent plan sponsor should require some evidence of a formal independent review on a regular basis if they are asked to sign a contract as a result of collective bargaining, and not due to an independent market review.

5. The union as fiduciary

In at least one instance, an employer who agreed to add a program through collective bargaining did so but refused to sign the contract with the union endorsed company. They required that the union sign the contract and assume the fiduciary liabilities that go with it. This option poses an interesting legal question. While a fiduciary can delegate all or some of their obligations to a discretionary trustee, you would need the opinion of your own legal counsel to determine whether or not your circumstances permit you to delegate fiduciary responsibility to a third party, and if so, who that third party can be. For example, even if you are able to delegate fiduciary responsibility to a third party, what due diligence must you perform to be certain you are delegating fiduciary responsibility to an entity that is financially sound and is qualified to act in that role? These are all questions for your legal counsel, but the delegation issue is in interesting concept when the employer agrees to add a vendor negotiated through collective bargaining and not through a formal bid process or market review.

6. How many programs are enough?

Finally, once an employer begins adding program options through collective bargaining, and not through a formal review process, it opens a floodgate for other employee groups to add their own endorsed program. There are many situations where a city or county has multiple vendors, most of whom were added through collective bargaining or because one particular group (management, unions or both) had a preferred vendor. These multiple-vendor programs can be very confusing to employees, and begs the question about who benefits from this –employees or the sponsoring organizations? It would be hard to demonstrate that you carried out your fiduciary duties in a responsible manner when all you did was add whatever programs you were asked to make available. At the end of the day, the plan sponsor is the fiduciary and has the liability that comes with it.

“Balkanization” of your plan is not a good solution

The term “balkanize” means to “ divide into small, quarrelsome, ineffectual states” as was the case with the break up of the Balkan states in Europe. Chopping up your defined contribution plan to accommodate various groups with financial interests in their own products or endorsement fees is not a prudent way to manage a pension program. A plan fiduciary should design your defined contribution plan “in the best interests of plan participants and their beneficiaries” and not for the benefit of other parties.

Unions and other employee and employer organizations can play an important role in public pension policy, and in the products, services and features a defined contribution plan should offer employees. These groups can play a valuable role as part of an overall review committee or board that selects a vendor to manage the plan for the benefit of all employees. This process is used by most larger plan sponsors and it works well to use combined purchasing power and collective talent to develop a program with low fees and attractive features available to all employees.

Chopping you plan up into small pieces, each one chosen through collective bargaining or political pressure, and not by independent review and evaluation, is not a “best practice” for a plan fiduciary. It entails risks for the plan sponsor and can hardly be viewed as being in the “best interests” of the employee.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal counsel on the impact of court rulings on their fiduciary liability.

Plan sponsors should take note: It is the employer (plan sponsor) who is responsible for monitoring fees charged to participant accounts, and not the record keeper or plan investment providers. Furthermore, the plan sponsor can be held financially liable for failing to act in the best interests of plan participants, especially when it comes to fees.

In a lengthy ruling handed down last month by the 8th U.S. Circuit Court of Appeals, the court affirmed what the Department of Labor (DOL) has been telling fiduciaries for years. The DOL position is that the plan sponsor must prudently monitor fees paid to plan providers. Plan sponsors can’t blame their inaction or ignorance on plan providers. The court held that the employer (Swiss-based ABB, Ltd) was liable for monitoring fees, and not Fidelity (the plan record keeper). The circuit court upheld the $13.4 million damage award against the employer. The court determined that ABB failed to complete its due diligence for fees paid to the record keeper.

The lawsuit is known as Tussey v. ABB, which has been winding through the courts since 2006. Aside from the issue of excessive record keeping fees, the lawsuit alleges breach of fiduciary duty for high investment management fees on mutual fund options, and earnings on “float” interest by the record keeper. The most recent ruling overturned a lower court decision against Fidelity on float income, and ordered the lower court to reconsider the $21.8 million granted to plaintiffs on excessive mutual fund fees. However, with respect to record keeping fees, the circuit court upheld the ruling against the employer for failing to monitor and take action on record keeping fees.

In the public sector, especially in the smaller-plan market, we sometimes hear employers say that they rely on the plan provider to monitor fees. Or, the plan sponsor, upon learning that their fees may be excessive, fails to take action in an expedient and prudent manner to remedy the situation. While this lawsuit is not over, the courts have thus far been consistent on the fee issue; that the plan sponsor is responsible for monitoring fees, and can be held financially liable for failing to do so.

Gregory Seller Consulting, LLC

All rights reserved. May not be reprinted in whole or in part without written permission. Provided for information only and is not legal or investment advice. Plan sponsors should seek their own legal counsel on the impact of court rulings on their fiduciary liability.

A qualified and objective consultant can be a great resource for plan fiduciaries in the prudent management of governmental, corporate, and non-profit pension programs. However, the important thing to consider in all consulting relationships is that the consultant is a resource, and not a shield.

A “Shield” or a “Resource”?

As a plan fiduciary, you are charged with making decisions in the “best interests of plan participants and beneficiaries.” No matter how many consultants you hire, you are still the fiduciary, and no multitude of consultants is going to relieve you of the serious responsibility to carry out your duties in the most prudent manner possible.

The use of a consultant can create a false sense of security, particularly in the governmental sector where there can be a tendency to use the consultant as a “shield” rather than a resource. If you are blindly following the advice of your consultant, without considering other sources of advice and input, then you are putting yourself at risk of only considering one source of professional guidance when making key decisions. Qualified consultants can be a valuable resource, but hiding behind their advice is not going to protect you from the risks of making ill-advised decisions. To the contrary, a plan fiduciary must be diligent to ensure that the advice they receive from their consultant is relevant and not, in itself, a conflict of interest (see Article Number One: Does Your Consultant Have a Conflict?).

A fiduciary should seek input and advice from a number of qualified sources. The fiduciary that seeks out advice from multiple parties to fulfill their duties is likely going to make more informed decisions than a fiduciary that blindly follows the advice of a single consultant.

Contrary Advice Can Be A Very Good Thing

Seeking out a second, third, or fourth opinion on anything can be a good practice. Whether it is your personal health, an investment decision, or management of a pension plan, seeking out other opinions is good behavior.

If you employ just one consultant for your pension plan, it is wise to purposely seek contrary viewpoints on important topics before making big decisions. If you are making a major decision on your pension program, you should seek out other opinions even if the advice of your consultant makes sense. Many times, the advice of a qualified consultant will result in the right decision being made. However if you don’t seek out alternative viewpoints, it is too easy to be on “consultant autopilot”, and therein lies a big problem for many governmental plan sponsors.

Other key points to consider:

If you don’t understand what your consultant is advising you to do, ask more questions. If you still don’t understand, don’t take action until you do. At the end of the day, you are accountable for the decisions and if you end up defending your actions in court, ignorance of the facts is not an excuse for failing to conduct fiduciary duties appropriately.

Ask other plan sponsors their opinion on key matters. If someone that is similarly situated to your circumstances made a different decision, ask them why. Document your discussion and share it with your other fiduciaries, even if you don’t agree with it.

A good consultant will give you options, since good plan governance does not always have absolute answers. If you aren’t being presented with options to key issues, ask why.

If your consultant makes the same recommendations (on plan design, investment structure, vendors) on other plans as yours, you should be certain you aren’t just getting “cookie cutter” advice that is pre-packaged, no matter who the client is.

Finally, you don’t have to always say “yes” to consultant recommendations to show that you are doing your job as a fiduciary. Sometimes it may be prudent to say no. There’s a difference between using consultants for advice and education vs. rubber-stamping all of their recommendations, and then hoping for the best.

Gregory Seller Consulting, LLC. All rights reserved. May not be reprinted in whole or in part without written permission.